Decentralization plays a key role in the security of any blockchain. The bigger is the number of nodes supporting the network, the higher is the level of its security. If one of the participants drops out, the network would still be able to function which eliminates dependence on a single authority and removes the risk of the whole system going down.
As the information about users’ interactions is recorded across the chain of interconnected blocks, none of the existing blocks can be altered or deleted. The only change that participants are able to perform is to find a new block to be added to this chain.
However, as the nodes act independently from each other, they have to agree upon a predefined set of rules that would determine which block can be added to the chain next. This is exactly what the consensus mechanism is responsible for.
Our experts at Numbrs have come up with a detailed explanation of how the most popular consensus mechanisms operate and how they are capable of providing the required level of security.
Proof-of-work consensus (PoW)
This type of algorithm was initially introduced together with Bitcoin back in 2008 and so far remains most popular when applied to cryptocurrencies. Here’s how it works.
In a PoW-based system, multiple nodes distributed across different regions compete with each other in resolving complex mathematical puzzles. It’s important to note here that while the search mechanics are complicated, checking the correct answer is pretty quick and easy.
As soon as one of the nodes finds the answer, it forms a new block and suggests adding it to the network. Other nodes instantaneously check whether the answer is correct and approve the request. As the new block is added to the chain, all others immediately start competing for the next one while the node that has managed to find it gets the reward. This process is called mining.
Bitcoin being the first cryptocurrency based on this principle is a classic example of the PoW-based network. Such an approach has both upsides and downsides.
- The miners bear high expenses on electricity and other aspects of mining. Therefore, in order to cover the costs, they have to sell the coins immediately instead of keeping them long-term. As a result, the market is never short of coins and there is no deficit.
- The bigger is the number of nodes in the system, the higher is its security as the 51% attack becomes way too expensive.
- PoW is pretty expensive and uses resources inefficiently. Costly equipment which quickly gets worn out is not the only type of expense that miners have to deal with. Add the excessive heat that it produces and high electricity bills with most of this heat and electric energy being simply wasted for nothing. Elon Musk with his ecologically-oriented Tesla surely doesn’t approve:
- PoW-based systems are very sluggish. On average, it takes whole 10 minutes for the BTC miners to find a new block. In addition, when the network gets congested, transaction fees skyrocket because of the system’s low throughput indices.
- It’s been long since bitcoins could be obtained on home PCs. Now that the difficulty of mining has increased multifold, the process can be accomplished only on specialized and very expensive equipment (ASICs). There’s just a small handful of providers that possess the majority of mining power which leads to higher centralization and increases the possibility of the 51% attack.
AreWeDecentralizedYet: the number of entities controlling the majority of the mining power is pretty small with PoW-based cryptocurrencies
Apart from Bitcoin, other examples of PoW-based cryptocurrencies include
- Bitcoin’s replicas such as Bitcoin Cash and Litecoin
- Dogecoin that has been recently promoted by notorious Elon Musk
- Ethereum Classic that rejects that path selected by Vitalik Buterin who has already switched his brainchild to the Proof-of-Stake
Now that PoS has been brought into the light, let’s review its peculiarities and how it is different from the first consensus mechanism.
Proof-of-Stake consensus (PoS)
In order to resolve the inefficiencies of the previous method and reduce the amount of resources needed to support the network, a new approach was proposed on the forum Bitcointalk in 2011. The topic starter suggested giving the voting rights not to those miners who share more resources, but to those who possess a bigger number of coins instead. This is how the Proof-of-Stake consensus came into the existence.
With PoS-based systems, the network participants “freeze” (i.e. stake) the coins on their accounts. The choice of the next block validator is based upon their economic share, i.e. the more coins one has staked the higher are his or her chances to contribute to the chain.
With that said, this method comes with the following pros and cons.
- The problem of excessive amounts of wasted resources has been resolved.
- PoS-based systems have much better scalability.
- Transactions are approved much faster.
- There is a threat of centralization. Big guys that control vast numbers of coins can influence the network.
- It’s more profitable to stake coins rather than spend them which makes the economy stagnate.
The most popular PoS-based coins include Lisk, Peeercoin, Cardano, and Tezos.
While PoW and PoS are the two key consensus algorithms utilized by cryptocurrencies, there is a whole lot of their derivatives. Such diversity has appeared thanks to Bitcoin’s open code that enables any enthusiast to develop something else aiming to resolve the key problems of an existing solution.
Some of the most popular alternatives include:
- Delegated-Proof-of-Stake (DPoS) where participants delegate their coins to a limited number of key representatives responsible for maintaining the network.
- Liquid-Proof-of-Stake (LPoS) which is similar to DPoS with the only difference that coin holders can delegate their votes to any other network participants instead of the short list of chosen ones.
- Proof-of-Elapsed-Time (PoET) designed by Hyperledger. This algorithm implies that all the nodes get a fair chance of validating the next block having waited a random amount of time and confirming this time in the block.
- Proof-of-Capacity (PoC) where miners can participate in the process with the help of the free space available on their hard drives.
- Proof-of-Importance (PoI) that is similar to PoS. What makes it different is that it considers not only the number of coins that participants stake but also the number of transactions that pass through their wallets, i.e. their activity.
- Proof-of-Space-and-Time (PoST) invented by the project Chia that has recently triggered the HDD sales boom. This consensus requires its participants to prove that some amount of disk space has been used for storing specific data and to ensure block time consistency.
This is just a tiny part of the variations that have gained the highest level of popularity. The full list of consensus algorithms deserves a separate article that we will publish later.
Now you may wonder which of the algorithms, PoW or PoS, would have a greater impact on the future development of the industry. Bitcoin with its ultra-dominating positions would hardly be replaced by any other coins, at least not in the nearest decade. However, the downsides of its consensus prevent it from getting applied anywhere beyond mere storage of value.
PoS-based systems, on the contrary, mostly focus on providing developers with some extra features that expand the usage of cryptocurrencies. Smart contracts featured by Ethereum and similar platforms represent a great innovation to fuel DeFi and related cryptocurrency-based products.